Italian Indirect Bond Issuances Possibly Affected by Changes to Withholding Tax Regime on Intra-group Interest Payments

With Law No. 111 of July 15, 2011, the Italian Parliament confirmed Law Decree No. 98 of July 6, 2011, whereby the Italian Government amended the rules implementing the E.U. Directive on intra-group payments of interest and royalties, contemplating that a 5% withholding tax apply on the intra-group interest payments encompassed under such rules in case the lender lacks the beneficial ownership requirement.  Such change is effective as of July 6, 2011.

In particular, the 5% withholding tax would be applicable to interest payments made to a qualifying E.U.-related lender not meeting the beneficial ownership test, otherwise eligible for the E.U. exemption, if such payments are ultimately used to fund interest payments due on bonds (i) traded on a qualifying regulated market within the E.U. or the E.E.A., and (ii) guaranteed by the Italian intra-group borrower or another qualifying group company. 

In addition, this piece of legislation introduces a 0.25% registration tax on the intra-group guarantee granted in connection with such bond issuances.  Finally, it contemplates that the new rules apply retroactively to interest already paid on intra-group loans outstanding on July 6, 2011 (i.e. the time in which they became effective), insofar as the borrower pays by November 30, 2011 a 6% rather than 5% tax (inclusive of the 0.25% registration tax), plus legal interest.

These rules follow a recent audit trend whereby the Italian tax administration has been closely scrutinizing financing structures benefiting from the E.U. intra-group interest exemption, including the fact pattern contemplated in the new set of rules: indirect bond issuances launched by Italian groups in the international debt markets, typically structured by resorting to an E.U.-based issuer guaranteed by its Italian parent company, that generally is the recipient of the proceeds raised on the market.  As a result, this change could be viewed as a means to provide certainty to the tax regime applicable to the outstanding and future issuances whereas the beneficial ownership test could be considered undermined by back-to-back contractual arrangements providing that the interest on the bonds be substantially funded by the remuneration on the intra-group on-lending.  However, this conclusion may not be applicable across the board to all structures as there may be circumstances where these structures may raise issues other than in connection with the beneficial ownership requirement and that may not be cured solely by this new set of rules. In such cases, the best course of action could be to proceed with direct issuances of bonds, which are fairly standard for the Eurobond market but not for Yankee bonds, requiring the implementation of complex procedures to ensure compliance with current applicable Italian tax rules.